(17E00104) FINANCIAL ACCOUNTING FOR MANAGERS * …

(17E00104) FINANCIAL ACCOUNTING FOR MANAGERS

The Objective of the course is to provide the basic knowledge of book keeping and

accounting and enable the students to understand the Financial Statements and make analysis

financial accounts of a company.

* Standard discounting and statistical tables to be allowed in the examinations.

1. Introduction to Accounting: Definition,Importance, Objectives, uses of accounting

and book keeping Vs Accounting, Single entry and Double entry systems,

classification of accounts – rules of debit & credit.

2. The Accounting Process: Overview, Books of Original Record; Journal and

Subsidiary books, ledger, Trial Balance, Final accounts: Trading accounts- Profit &

loss accounts- Balance sheets with adjustments, accounting principles.

3. Valuation of Assets: Introduction to Depreciation- Methods (Simple problems from

Straight line method, Diminishing balance method and Annuity method). Inventory

Valuation: Methods of inventory valuation (Simple problems from LIFO, FIFO,

Valuation of goodwill - Methods of valuation of goodwill.

4. Financial Analysis -I Analysis and interpretation of financial statements from

investor and company point of view, Liquidity, leverage, solvency and profitability

ratios – Du Pont Chart -A Case study on Ratio Analysis

5. Financial Analysis-II: Objectives of fund flow statement - Steps in preparation of

fund flow statement, Objectives of Cash flow statement- Preparation of Cash flow

statement - Funds flow statement Vs Cash flow statement.

Textbooks:

Financial Accounting, Dr.S.N. Maheshwari and Dr.S.K. Maheshwari, Vikas

Publishing House Pvt. Ltd.,

Accountancy .M P Gupta & Agarwal ,S.Chand

References:

Financial Acounting , P.C.Tulisan ,S.Chand

Financial Accounting for Business Managers, Asish K. Bhattacharyya, PHI

Financial Accounting Management An Analytical Perspective, Ambrish Gupta,

Pearson Education

Accounting and Financial Management, Thukaram Rao, New Age Internationals.

Financial Accounting Reporting & Analysis, Stice & Stice, Thomson

Accounting for Management, Vijaya Kumar,TMH

Accounting for Managers, Made Gowda, Himalaya

Accounting for Management , N.P.Srinivasan, & M.Shakthivel Murugan, S.Chand

UNIT-1 Introduction to Accounting | BALAJI INST OF IT AND MANAGEMENT 2

UNIT-1

INTRODUCTION TO ACCOUNTING

1. Account:

Def: The term account may means

Purchase or sale of goods or an asset on credit.

Receipt or payment of money in part settlement of an existing account.

Receipt or payment of money on account of previous due or receivable or payables.

DEFINITION OF ACCOUNTING: “The American Institute of Certified Public

Accountants has defined “Accounting is a recording classifying summarizing& reporting to

the business transaction”.

“Accounting is a means of measuring and reporting the results of economic activities”

- Smith and Ashburne –

“Accounting systems is a means of collecting, summarizing, analyzing and reporting

in monetary terms, the information about the business”.

- R.N.Anthony –

“The art of recording, classifying and summarizing in a significant manner and in

terms of money transactions and events, which are, in part at least, of a financial character

and interpreting the results thereof”.

- American Institute of Certified Public Accountants (AICPA) –

1.1Accounting: American Institute of Certified Public Accountant (AICPA)

Accounting is the art of recording business transactions classify and summarizing in a

significant manner and in terms of money transactions and events with in part at least of a

financial and interpreting the results thereof.

Ex:

1. B has paid Rs.1,00,000/- to X

2. N has paid Rs. 25,000/- to Business

3. Puneth today is leave

4. A has received Rs.1000


1.2 Meaning of accounting:Accounting is a language of business.

“The art of recording, classifying and summarizing in a significant manner in terms

of money transactions”.

1.3Introductions:

The main aim of a business is to earn profit. For earning profit, the businessman

will either purchase the goods in one market at certain price and sell it in another

market at higher price or will convert the raw materials into finished products and

sell it to the different customers at a price which will give him some percentage of

profit on cost of production. But this may not be true in all cases.

Sometimes it may happen that the goods purchased or produced may go out of

fashion and may be saleable simply because of depression in the market or keen

competition.

He may be able to sell the goods either at a loss or at a very small margin.

However, he will be anxious at the end of the year to find out whether his goods

taken together have been sold at a profit or at a loss and what is financial

condition on a particular date. Moreover in big business information is required

for planning, control, evaluation of performance and decision making.

This information can be provided only when business transactions are record,

classified and summarized properly.

In order to achieve the above purposes it would be necessary to record business

transactions according to well devised system. Accounting name given to such a

system.

1.4History of Accounting:

Accounting is as old as civilization itself. From the ancient relies of Babylon, it can be

well proved that accounting did exist as long as 2600 B.C.

However, in modern form accounting based on the principles of Double Entry

System, which came into existence in 15th century.

Fra Luka Paciolo, a mathematician published a book De competence scriptures in

1494 at Venice in Italy. This book was translated in to English in 1543. In this book

he covered a brief section on ‘book-keeping’.

Paciolo used the terms ‘debito’ and ‘credito’ these words came from latic words

debeo and credo. The terms debit and credit used to day have its origin from debito

and credito.


1.5Origin of Accounting in India:

Accounting was practiced in India thousand years ago and there is a clear evidence for

this. In his famous book Arthashastra ‘Kautilya’ dealt with not only politics and

economics but also the art of proper keeping of accounts.

However, the accounting on modern lines was introduced in India after 1850 with the

formation of joint stock companies in India.

Accounting in India is now a fast developing discipline.

The two premier accounting institutes in India viz., chartered Accountants o India and

the Institute of Cost and Works Accountants of India are making continuous and

substantial contributions

2. IMPORTANCE OF ACCOUNTING:

i) Replacement of Human Memory:as the human’s memory is limited and short, it is

difficult to remember all the transactions of the business. Therefore, all the financial

transactions of the business are recorded in the books. By this way the businessmen cannot

only see the records at the required time but can also remember them for a long time.

Thus, recording of the transactions is the replacement of human’s memory.

ii) Helpful In The Determination Of Financial Results And Presentation Of

Financial Position: accounting is very useful in the determination of the profit and loss of

a business and showing the financial position of the business.

iii) Helpful in assessing the tax liability: generally,: a businessman has to pay corporate

tax, VAT and excise duty, etc. therefore, it is necessary that proper accounts should be

maintained to compute the tax liability of the business.

iv) Helpful in the case of insolvency: sometimes the businessman becomes the

insolvent. If he has properly maintained the accounts, he will not face the problems in

explaining few things in the court.

v) Helpful in the valuation of business: if the business is shut down and sold,

accounting helps the businessman to determine the value of business. It would be possible

only in that case when the accounts of the business are properly maintained.


vi) Helpful in the valuation of goodwill and shares: if accounts of the business are

properly maintained, it would be quite convenient to determine the value of goodwill.

Goodwill is very important for the determination of the value of shares of the company.

vii) Accounting makes comparative statement possible: proper and adequate

accounting helps in comparing the income, expenditure, purchase, sale of the current year

with that of the previous years. And then future plans, policies and forecasting may be

possible.

viii) It helps to make inter period and interfirm comparison. Accounting information

recorded properly can be used to compare the results of one year with those of previous

years and with those of their other enterprises.

ix) It is an aid to the management.: The information recorded properly can be used for

meaning full analysis, so as to assist the management in decision making.

x) It is needed for legal reasons:. Accounting information as recorded can be produced

as a firm, evidence in a court of law. It helps in taxation matters and finalizing other

contract details, etc.

3. OBJECTIVES OF ACCOUNTING:

1. Designing Work: It includes the designing of the accounting system, basis for

identification and classification of financial transactions and events, forms, methods,

procedures etc.,

2. To maintain records of business: One of the important objectives of accounting is the

systematic maintenance of all monetary aspects of business transactions. This Is known as

book-keeping.

3. To calculate Profit or Loss: The profit earned or the loss suffered during a specific

period can be calculated easily from the accounting books.

4. To ascertain financial position: By preparing the financial statements profit and loss

account and balance sheet, the financial position of the business can be found out. Form

these statements it is possible to know the resources owned by the firm. These statements

also provide information about the obligations of business. Thus accounting aims at

depicting the true and fair financial position of a concern.


5. TO communicate financial information: Accounting is called language of business. It

aims at communicating financial information to various interested parties.

6. Preparation of Budget: The management must be able to reasonably estimate the future

requirements and opportunities. As an aid to this process, the accountant has to prepare

budgets, like cash budget, capital budget, purchases budget, sales budget etc. this is known

as ‘Budgeting’.

7. Taxation work: The accountant has to prepare various statements and returns pertaining

to income-tax, sales-tax, excise or customs duties etc., ant file that returns with the

authorities concerned.

8. Auditing: It involves a critical review and verification of the books of accounts

statements and reports with a view to verifying their accuracy. This is ‘Auditing’.

4. USE, NATURE,FUNCTIONS AND SCOP OF ACCOUNTING

1) Recording:This is the basic function of accounting. It is essentially concerned not only

with ensuring that all business transactions of financial character are recorded, but also that

they are recorded in an orderly manner. Recording is done in the book “journal”. This may be

further subdivided into various subsidiary books such as cash journal, purchases journal, sales

journal etc. the number if subsidiary books to be maintained will be according to the nature

and size of the business.

2) Classifying: classification is concerned with the systematic analysis of the recorded data,

with a view to group transactions or entries of one nature at one place. The work of

classification is done in the book termed as “Ledger”. This book contains on different pages,

individual account heads under which, all financial transactions of similar nature are

collected. For example, there may be separate account heads for traveling expenses, printing

and stationery, advertising etc. all expenses under these heads, after being recorded in the

journal, will be classified under separate heads in the ledger. This will help in finding out the

total expenditure incurred under each of the above heads.

3) Summarizing: this involves presenting the classified data in a manner which is

understandable and useful to the internal as well as external end-users of accounting

statements. This process leads to the preparation of the following statements:

i) trial balance

ii) income statement and

iii) balance sheet


4) Dealing with financial transactions: accounting records only those transactions and

events in terms of money which are of a financial character. other transactions are not

recorded in the books of account. For example, if a company has a team of dedicated and

trusted employees, it is of great use to the business; but since it is not of a financial character

and not capable of being expressed in terms of money, it will not be recorded in the books of

business.

5) Analyzing and interpreting: this is the final function of accounting. The recorded

financial data is analyzed and interpreted in a manner that will enable the end-users to make a

meaningful judgment about the financial condition and profitability of the business

operations. The data is also used for preparing future plans and framing the policies for

executing such plans.

6) Communicating: the accounting information after being meaningfully analyzed and

interpreted has to be communicated in a proper form and manner, to the proper person. This

is done through preparation and distribution of accounting reports, which include – besides

the usual income statement and the balance sheet economists the marginal cost refers to the

cost of producing one additional unit. Such cost per unit may increase or decrease depending

upon the law of returns. For example in the case of law of increasing returns, the cost per unit

5 BOOK-KEEPING Vs ACCOUNTING

Sl.No Points of

Difference Book-Keeping Accounting

1 Object The Object of Book-Keeping is to

prepare original books of Accounts.

The main object of accounting is to

record, analyze and interpret the

business transactions.

2 level of

work

Book-Keeping is restricted to level of

work. Clerical work is mainly involved

in it.

Accountancy on the other hand, is

concerned with all levels of

management

3 Principles of

Accountancy All without any difference.

On the other hand, various firms

follow various methods of reporting

and interpretation in accounting.

4 Final Result

In Book-Keeping it is not possible to

know the final result of business every

year.

Accounting gives the net results of

the business every year.


5.1 Objects of book-keeping at a glance

6. SINGLE ENTRY SYSTEM

Single entry system is an incomplete form of recording financial transactions.

It is the system, which does not record two aspects or accounts of all the financial

transactions.

It is the system, which has no fixed set of rules to record the financial transactions of

the business. Single entry system records only one aspect of transaction.

Thus, single entry system is not a proper system of recording financial transactions,

which fails to present complete information required by the management.

Single entry system mainly maintains cash book and personal accounts of debtors and

creditors.

Single entry system ignores nominal account and real account except cash account.

Hence, it is incomplete form of double entry system, which fails to disclose true profit

or loss and financial position of a business organization.

6.1 Features of single entry system

1. No Fixed Rules: Single entry system is not guided by fixed set of accounting rules for

determining the amount of profit and preparing the financial statements.

PRIMARY OBJECTS

Sub-Objects Ancillary Objects

To know

Profit/Loss

To know

Financial

Position

To have a

systematic

record

To Know

Creditors

To Know Debtors

To know capital

Invested

To understand

cash and stock

To review the progress

To prevent errors &

Frauds

To keep a check on

property

To provide valuable

information for

decision-making


2. Incomplete System: Single entry system is an incomplete system of accounting, which

does not record all the aspects of financial transactions of the business.

3. Cash Book: Single entry system maintains cash book for recording cash receipts and

payments of the business organization during a given period of time.

4. Personal Account: Single entry system maintains personal accounts of all the debtors and

creditors for determining the amount of credit sales and credit purchases during a given

period of time.

5. Variations in Application: Single entry system has no fixed set of principles for recording

financial transactions and preparing different financial statements. Hence, it has variations in

its application from one business to another.

Single Entry vs. Double Entry Accounting

The single entry approach contrasts with double entry accounting, in which every financial

event brings at least two equal and offsetting entries. One is a debit (DR) and the other a

credit (CR). As a result:

Firms using the double entry approach report financial results with an accrual

reporting system.

Firms using single entry approach are effectively limited to reporting on a cash basis.

7. DOUBLE ENTRY SYSTEM

Every transaction as two aspects when you received some thing we give something

else in written. “Rule Double entry system. Purchase goods for cash. “Every debit

they must be a corresponding credit”.

In these business transaction we receive goods and give cash in return similarly when

we sale goods on credit goods are given another customer becomes debtors these

method of writing may transaction divided into two types debt and credit.

One account is to be debt and another account is credit for every transaction in order

to have a complete record of the same.

Every transaction effects two accounts in opposite direction a transaction is to be

recorded in two different accounts in opposite side for annual value both the accounts

cannot be debted and another account is to be credit the basic principle of double

entry systems is to every debt they must be corresponding credit of equal value.

Double entry system is a scientific way of presenting accounts. As such all the

business concerns feel it convenient to prepare the accounts under double entry


system. The taxation authorities also compel the businessmen to prepare the accounts

under double entry system.

Under dual aspect concept the Accountant deals with the two aspects of business

transaction. i.e.

1. Receiving aspect (Debit Aspect)

2. Giving aspect(Credit Aspect)

In double entry system book-keeping system these two aspects are recorded facilitating

the preparation of trail balance and the final accounts there from.

7.1 Principle of double entry system

The systematically way of presenting the accounts is duly under the double entry

system. Single entry system is in fact not a system at all. It is nothing but an

incomplete form of double entry.

Every business transaction has got two accounts, where one account is debited and

other account is credited.

If own account receives a benefit, there should be another account to part the benefit.

The principle of double entry is based on the fact that there can be no giving without

receiving nor can there be receiving without something giving.

7.2 Advantages double entry system:

1.Scientific System: Double entry system records, classifies and summarizes business

transactions in a systematic manner and, thus, produces useful information for decision-

makers.

2.Full Information: Full and authentic information can be had about all transactions as the

trader maintains the ledger with all types of account.

3.Assessment of Profit and Loss: The business man/trader will be able to known correctly

whether he had earned profit or sustained loss. It facilitates the trade to take such steps so as

to increase the efficiency of the firm.

4.Knowledge of debtors: The trader will be able to know exactly what amounts are owed by

different customers to the firm. If any amount is pending for a long time from any customer,

he may stop credit facility to that customer.

5.Knowledge of Creditors: The trader also knows the exact amounts owed by the firm to

others and he will be able to arrange prompt payment to obtain cash discount.


6.Arithmetical accuracy: The arithmetical accuracy of the books can be proved by

preparing trail balance.

7.Assessment of Financial Position: The trader will be able to prepare the balance sheet

which will help the interested parties to know fully about the financial position of the firm.

8.Comparison of results: It facilitates the comparison of current year’s results with of

previous years.

9.Maintenance according to Income Tax Rules: Proper maintenance of books will satisfy

the tax authorities and facilitates accurate assessment. In India joint stock companies should

maintain accounts under double entry system.

10. Detection of frauds: The systematic and scientific recording of business transaction on

the basis of this system minimizes the chances of embezzlement and frauds. The frauds or

errors can be easily detected by vouching. Verification and auditing of accounts.

7.3Disadvantage double entry systems:

1.Errors of Omission: In case the entire transaction is not recorded in the double of

accounts the mistake cannot be detected by accounting. The Trail Balance will tally in spite

of the mistakes.

2.Errors o principle: Double entry is based upon the fact that every debit has to

corresponding credit. It will not be able to detect the mistake such as debiting Ram’s account

instead of Rao’s account or building account in place of repairs account.

3.Compensating errors: If Rahim’s account is by mistake debited with Rs.15 lesser and

Mohan’s account is also by mistake credited with Rs.15 lesser, the Trail balance will tally

but mistake will remain in accounts.

8. CLASSIFICATIONS OF ACCOUNTS (OR) TYPES OF ACCOUNTS

PERSONAL ACCOUNTS IMPERSONAL ACCOUNTS

Natural Artificial Representative Real Nominal

Personal A/C Personal A/C Personal A/C Accounts Accounts

Tangible Intangible

Accounts Accounts


9.RULES OF THE DOUBLE ENTRY SYSTEMS

I. personal accounts: these accounts record a business’s dealings with persons or firms. The

person receiving something is given debited and the person giving something is given credit.

a) Natural Personal A/C: An account recording transactions with and individual human

being is known as natural personal accounts.

Ex:Ramu A/C, Sindhu A/C, Nagendra A/C.

b)Artificial Personal A/C: An account recording financial transactions with an artificial

person created by law are called as artificial personal accounts.

Ex: SBI Bank A/C, Satyam InfoTech Ltd A/C

c)Representative personal A/C: An account indirectly representing a person or group of

persons is known as representative personal A/C.

Ex: Salaries outstanding A/C, Interest outstanding A/C

Rule:Debit the receiver ,Credit the giver

II.Real Accounts: Real accounts means the business transactions deal with assets. these are

the accounts of assets, asset entering the business is given credit. Real accounts again

classified into two types i.e.,

1. Tangible real A/C

2. Intangible Real A/C

a) Tangible Real A/C: It relates to an asset which can be touchable felt sun and

measured.

Ex: machinery A/C, Cash A/C

b) Intangible Real A/C: It relates to an asset which can be touched physically but can be

measured in valued.

Ex: Goodwill A/C, Patents A/C

Rule: Debit what comes in Credit what goes out

IIINominal Accounts: It means the business transaction deals with an expenses, loss

incomes, and gains. Accounts of expenses and losses are debited and accounts of incomes

and gains are credited.

Rule:Debit all expenses and losses, Credit all incomes and gains


9.1Advantages of accounting:

1. Provides fro systematic records: since all the financial transactions are recorded in

the books, one need not rely on memory. Any information required is readily

available from these records.

2. Facilitate the preparation of financial statements: Profit and loss account and

balance sheet can be easily prepared with the help of the information in the records.

This enables the trader to know the net result of business operations during the

accounting period and the financial position of the business at the end of the

accounting period.

3. Provides control over assets: Book-keeping provides information regarding cash in

hand, cash at bank, stock of good, accounts receivables from various parties and the

amounts invested in various other assets. As the trader knows the values of the assets

he will have control over them.

4. Provides the required information: Interested parties such as owners, lenders,

creditors etc., get necessary information of frequent intervals.

5. Comparative study: One can compare the present performance of the organization

with that of its past. This enables the managers to draw useful conclusions and make

proper decisions.

6. Less scope for fraud or theft: It is difficult to conceal fraud or theft etc., because of

the balancing of the books of accounts periodically. As the work is divided among

many persons, there will be check and counter check.

7. Tax matters: Properly maintained book0keeping records will help in the settlement

of all tax matters with the tax authorities.

8. Ascertaining value of business: The accounting records will help in ascertaining the

correct value of the business. This helps in the even of sale or puchase of a business.

9. Documentary evidence: Accounting records can also be used as evidence in the

court to substantiate the claim of the business. These records are base on documentary

proof. Every entry is supported by authentic vouchers. As such, courts accept these

records as evidence.

10. Helpful to management: Accounting is useful to the management in various ways. It

enables the management to find the achievement of its performance. The weakness of

the business can be identified and corrective measures can be applied to remove them

with help of accounting.


9.2 Limitations of accounting:

1. Does not record all events: Only the transactions of a financial character will be

recorded under bookkeeping. So it does not reveal a complete picture about the

quality of human resources, location advantage, business contacts.

2. Does not reflect current values: The data available under book-keeping is historical

in nature. So they do not reflect current values. For instance, we record the value of

stock at cost price or market price, whichever is less.

3. Estimates based on Personal Judgment: The estimates used for determining the

values of various items May not be correct.

4. Inadequate information on costs and profits: Book-keeping only provides

information about the overall profitability of the business. No information given about

the cost and profitability of different activities of products or divisions.

ACCOUNTING TERMS:

1. Business: It is an activity involves exchange of goods or services with the intention of

earning income and profit.

2. Business transaction: Business transaction an exchange of more aspects as goods

and services between two parties.

Ex:

a) Goods purchase to Mr. X

b) Goods sold to Ms. Y

c) Cash received

d) Cash Paid

e) Land sold – The types business transaction are classified in three

f) Machinery Purchased

3. Trail Balance: A list of debit and credit balances of all the ledger account is prepared

on any particular date in order to certify in arithmetically.

4.Expenses:

2 types

Direct: – wages (Factory related), fuel, power etc.

Indirect: - Salary etc.


5.Difference between Debtors and Creditors:

a. A debtor is a person who owes money to business, but a creditor is a person to whom

the business owes money.

b. A person becomes a debtor of a business where he has received some benefit from the

business but a person becomes a creditor of a business when he has given some

benefit to the business.

c. Debtor constitutes assets for the business. Creditors constitute liabilities for a

business.

d. Account of a debtor shows debit balances and account of creditors shows credit

balances.

6.Equity:All claims against the assets of business are called equity the claim of outsiders

is creditor’s equity or liability the claim of the properties is called owner equity or capital.

7.Revenue or Income: Revenue refers to the earning of a business it include the sale

process of goods, receipts for services rendered and earning from interest,

commission.Thisreefers to earnings of the business. It includes the sales proceeds of

goods, receipts for services rendered.

Eg: Earnings from interest, dividend, rent, commission, discount etc.

8.Expense:It is amount spend in conducting business action. It is the expenditure in

return for some benefits. An expense refers to expenditure in return for some benefit is

received and the benefit received is enjoyed and exhausted immediately.

Eg: Salary paid to staff, rent paid to land lord, transportation paid, and electricity charges

paid. An expense refers to expenditure in return for some benefit is received and the

benefit received is enjoyed and exhausted immediately.

Eg: Cost of goods sold, salaries, printing and stationery, and telegram etc.,

9. Loss:Loss refers to money or monies worth given up without or benefit in return it is

an expenditure in return for which no benefit is received

Eg: Loss of goods fire, damages paid to others loss difference for expense an expense

brings some benefit whereas loss does not bring my benefit rent paid is an expense but

goods destroy fire is loss. It refers to money or money worth given up without any benefit

in return.

Eg: Loss of goods by fire, be theft, damage paid to others etc.,


KEY WORDS

1. Assets: The valuable things owned by the business are known as assets. These are the

properties owned by the business.

a. Fixed Assets: These assets are acquired for long-term use in the business. They are

not met for resale. Land and Building, plant and machinery, vehicles and furniture

etc., are some of the examples of fixed assets.

b. Liquid Assets: These assets also known as circulating, fluctuating or current assets.

These assets can be converted into cash as early as possible. Current assets are cash,

bank balance, debtors, stock, and investments.

c. Fictitious assets: Fictitious assets are those assets, which do not have physical form.

They do not have any real value. The example of these assets are loss on issue of

shares, preliminary expenses etc.,

d. Intangible assets: Intangible assets are those having no physical existence goodwill,

patents, trademarks are the examples.

e. Wasting Assets: Wasting assets are those assets which are consumed through being

worked or used. Mines are the examples of wasting assets.

2. Capital: It is the part of wealth which is used for further production and thus capital costs

of all current assets and fixed assets. Cash in hand, cash at bank, buildings, plant and

furniture etc., are the capital of the business. Capital is classified as

a. fixed capital

b. Working Capital

a. Fixed Capital: The amount invested in acquiring fixed assets is called fixed capital. Plant

and machinery, vehicles, furniture and buildings etc., are some the examples of fixed capital.

b. Working Capital: The part of capital available with the firm for day0to-day working of the

business is known as working capital. Working capital can also be expressed as under.

Working Capital = Current Assets – Current Liabilities

3. Liabilities: Liabilities are the obligations or debts payable by the enterprise in the future

in the form of money or goods. Liabilities can be classified as

a. Fixed Liabilities

b. Current Liabilities

c. Contingent Liabilities


a. Fixed Liabilities: These liabilities are payable generally, after a long period.

Capital, Loans, debentures, mortgage etc., is its examples.

b. Current Liabilities: Liabilities payable within a year are termed as current

liabilities. The value of these liabilities goes on changing. Creditors, bills payable

and outstanding expenses etc., are current liabilities.

c. Contingent Liabilities: These are not the real liabilities. Future events can only

decide whether it is really a liability or not. Due to their uncertainty, these

liabilities are termed as contingent liabilities.

4. Transaction: It refers to any happening event which is measurable in terms of money and

which changes the financial position of the business concern. Types of transaction.

Any sale or purchase of goods or services is called the transaction. Transactions are of

three types.

a. Cash Transaction

b. Credit Transaction

c. Non-cash Transaction

a. Cash Transaction: Cash transaction is one where cash receipt or payment is involved in

the exchange.

b. Credit Transaction: Credit transaction will not have cash, either received or paid, for

something given or received,, respectively. Credit transactions give rise to debtor and

creditor relationship.

c. Non-cash Transaction: It is a transaction where the question of receipt or payment of

cash does not arise at all.

Ex: Depreciation, return of goods, and bad debts etc.

5. Account: A summarized statement of transactions relating to a particular person, thing,

expense or income.

6. Proprietor: Proprietor is the person, who owns the business. He invests capital in the

business with the object of earning profits. Proprietor is an individual in case of sole trading,

partner in case of partnership firms and shareholder in case of companies.


7. Drawings: Cash or goods withdrawn by the proprietor from business for his personal or

household use are termed as ‘drawings’.

8. Solvent: One who is able to pay one’s debts when they become due.

9. Insolvent: The inability of a person to pay his debts when they become due. The condition

in which the liabilities exceed assets.

10. Debtors: Debtor means a person who owes money to the trader.

11. Creditor: A creditor is a person to whom something is owned by the business. He is a

person to whom some amount is payable for loan taken, services obtained or goods bought.

12. Equity: A claim which can be enforced against the assets of a firm is called equity. The

equities of a firm are of two types

a. Owner’s equity or capital &

b. Creditor’s equity

13. Goods: All those things which a firm purchases for resale are called goods.Goods refers

to commodities, articles, services or things in which trader deals goods refers to commodities

or things intended to resale unsold goods, lying in a business concern on any given date are

called stock

14. Purchases: Purchases means purchase of goods, unless it is stated otherwise. It also

represents the goods purchased.

15. Sales: Sales means sale of goods, unless it is stated otherwise. It also represents the goods

sold.

16. Revenue: Revenue in accounting means the amount released or receivable from the sale

of goods.

17. Discount: There are two types of discount.


a. Cash Discount: An allowance made to encourage prompt payment or before the expiration

of the period allowed for credit.

b. Trade discount: A deduction from the gross or catalogue price allowed to traders who buys

them for resale.

18. Voucher: Accounting transactions must be supported by documents. These documentary

proofs in support of the transactions are termed as vouchers.

19. Reserve: An amount set aside out of profits or other surplus and designed to meet

contingencies.

20. Losses: It is to be distinguished from expense. An expense is supposed to bring some

benefit to the firm, whereas a loss will not. Loss by fire or theft is an example.

21. Revenue or Income: Revenue refers to the earning of a business it include the sale

process of goods, receipts for services rendered and earning from interest, commission. This

refers to earnings of the business. It includes the sales proceeds of goods, receipts for services

rendered.

Eg: Earnings from interest, dividend, rent, commission, discount etc.

22. Accounting period: A period of 12 months for which the accounts are usually kept. It

may be calendar year (Jan 1st to Dec 31st) or financial year(April 1st to March 31st).

23. Gross profit: The difference between the selling price and the cost price of goods, before

the deduction of any expenses incurred in selling goods.

24. Net profit: The profit that remains after deducting all the expenses from the gross profit.

It represents the real gain of the business.

25. Profit and Loss account: It is a statement prepared by the businessman for the

ascertainment of profit or loss during the accounting period.


26. Balance Sheet: It is a statement of assets and liabilities prepared with a view to measure

the exact financial position of a business on particular date, generally the last of the

accounting period.

ACCOUNTING EQUATION:

American accountants have derived the rules of debit and credit through accounting equation

which is given below:

Assets = Equities

The equation is based on the principle that accounting deals with property and rights to

property and the sum of the properties owned is equal to the sum of the rights to the

properties. The properties owned by a business are called assets and the rights to properties

are known as liabilities or equities of the business.

Equities may be divided into equities of creditors representing debts of the business known as

liabilities and equity of the owner known as capital. Keeping in view the two types of equities

the equation given above can be stated as below:

Assets = liabilities capital

Or Capital = assets-liabilities

Or Liabilities = Assets – capital

UNIT-1 IMPORTANT QUESTIONS

Importance, of accounting &Book keeping Vs accounting?

Advantages & Dis-Advantages of Single& double entry system?

Classification of accountings with rules &examples?






















Textbooks:




References:




Pearson Education






UNIT-2 THE ACCOUNTING PROCESS | BALAJI INST OF I.T AND MANAGEMENT 2

UNIT-2

THE ACCOUNTING PROCESS

1. ACCOUNTING OVERVIEW

Every company has an accounts department that looks after the accounting details of

the company.

An accounting department is the backbone of every business. It records all the

business transactions and keeps a track of the incomes and expenses of the business.

The business depends on these incomes for its profits and should know all the

expenses that are incurred to keep it going.

They also determine the correct financial position and financial standing of the

business.

All this makes the recording of transactions important.

For the systematic and accurate recording of the transactions, accounting is important.

Let us understand the accounting process in detail.

The purpose of accounting is recording all the transactions honestly and accurately in

the books of accounts.

The accounting process can be defined as "the process that begins when the

transaction takes place and ends when the transaction is recorded in the books of

accounts".

It is a series of procedures that are used to analyze and record the business

transactions for a particular period of time.

Final Accounts

Journal

Ledger Accounts

Trail Balance

1. Cash Book. 2. Purchase Book

3. Sales Book 4. Purchase returns

Book 5. Sales Returns book.

6. Bills received book 7. Bills payable book

8. Journal proper


The accounting process, also known as the accounting cycle process, includes the

steps mentioned below. In order to follow these steps, you will need to know all the

accounting principles and concepts well.

The first step involves identifying the transaction and finding the source documents of

the transaction.

Analyze which accounts is the transaction affecting and what is the amount of the

transaction.

Record the entry into the journal as a credit or debit, according to its nature.

Transfer the journal entries into the appropriate accounts in the ledger.

A trial balance is then created which sees to it that the debit amount equals the credit

amounts.

Correct the discrepancies in the trial balance and balance the debit side with the credit

side.

Make adjusting entries in order to record the accrued and deferred amounts.

Next, prepare the adjusted trial balance on the basis of the deferred amounts.

Prepare the financial statements like the income statements, the balance sheet,

retained earnings statements and finally the cash flow statements.

Close the temporary accounts like revenues, expenses, gains, etc. by closing journal

entries. These accounts are transferred to the income summary account and later

posted into the capital accounts.

Prepare the final trial balance on the basis of the closing journal entries.

2. BOOKS OF ORIGINAL RECORD

2.1JOURNAL:Journal is derived from the French word ‘jour’ which means a day. Journal,

therefore, means a daily record of business transactions. Journal is a book of original entry

because transaction is first written in the journal from which it is posted to the ledger at any

convenient time. The ruling of the journal is as follows:

Journal

Date Particulars L.F. Dr.Amount

Rs.

Cr. Amount

Rs.

Year

Month

Date

Name of account to be debited

To Name of Account to be credited

(Narration)

(A) (B)


Column 1 (date): the date of the transaction on which it takes place is written in this column.

The year is written only in the first entry appearing on each page. This column is divided into

two parts: the first part is used for writing the month and the second part is used for writing

the date.

Column2 _ (particulars): in this column, the name of the account to be debited is written

first and is written close to the line marked (A). The word Dr. is written near the line marked

(B). In the next line, the account to be credited is written preceded by the word “To” leaving

a few spaces away from the (A). an explanation of the entry known as “narration” is also

recorded in this column below the line giving credit to the account.

Column 3 – (L.F.) L.F. stands for ledger folio which means page of the ledger. In this

column are entered the page numbers on which the various accounts appear in the ledger.

Column 4 _ (Dr. Amount): in this column, the amount to be debited against the ‘Dr’.

Account is written along with nature of currency.

Column 5_ (Cr. Amount) in this column the amount to be credited against the ‘Cr’. Account

is written along with the nature of currency.

We may define a few more items relating to the journal.

Journalizing means recording a transaction in the journal and the form in which it is recorded

is known as journal entry.

If two or more transactions of the same nature occur on the same day and either the

debit account or credit account is common, such transactions can be conveniently entered in

the journal in the form of a combined journal entry instead of making a separate entry for

each transaction. Such type of entry is known as a compound journal entry.

In a going concern, the balances of the previous year appearing in various accounts

are brought forward at the beginning of the new accounting year by means of a journal entry

known as opening entry to incorporate the previous balances in a new set of accounts. All the

assets accounts are debited and liabilities is credited to capital account.


2.1.1 Steps in journalizing:

1. Ascertain the accounts involved in the transactions.

2. Ascertain the nature of account involved i.e., personal A/c (or) Real A/c (or) Nominal

A/c.

3. Ascertain which rule of debit and credit is applicable for each of the accounts

involved.

4. Ascertain which account is to be debited and which account is to be credited.

5. Record the date of transactions in the date column.

6. Write the name of account to be debited very close to left hand side with the

abbreviation ‘Dr.” on the same line in the extreme right hand side of particulars

column. The amount to be debited is written in the debit amount column on the same

line against the name of account.

7. Write the name of account to be credited in the next line. It should be precise by word

‘To’ at a few spaces towards right in the particulars column and the amount to be

credited in the credit amount column against the name of account.

8. Write the narration ( a brief explanation of the transactions) with in the brackets and

in the next line in the particulars column.

9. Draw a line across the entire ‘particulars column’ to separate one entry from the other

entry. The line should be drawn only in the particulars columns.

Note: the word account should be suffered to both debit and credit aspects of journal entry.

2.1.2 Points to be noted before journalizing:

1. Capital account: if the proprietor has introduced cash or goods or property in business, it

is known as capital. It should be debited to cash/stock of goods/property account and credited

to the proprietor’s capital account. It must be clearly understood that the entity of the

proprietor is totally different from the business.

2. Drawings account: if the proprietor has withdrawn cash or goods from the business for his

personal or domestic use, it is called drawings. It should be debited to drawings account and

credited to cash/ purchases account.

3. Cash/credit transactions: when goods are purchased or sold for cash, it is known as cash

transaction. If the goods are purchased or sold on credit i.e., the payment will be made or

received after sometime, it will be a credit transaction. If nothing is mentioned whether it is a

credit or cash transaction, then it should be treated as a credit transaction. For example, goods

sold to X for Rs.2,000 or goods purchased form Y for Rs. 1,000 etc.


4. Casts and Carry forwards: when journal entries extend to several pages of the journal,

the totals are cast at the end of each page. At the end of each page the words ‘ Total C/f

stands for carried forward are written in the particulars column against the debit and credit

totals. On the next page, in the beginning the words

Total b/f” is written in the particulars column against the debit and credit totals. At the end of

a specified period or on the last page, the grand total is cast.

5. Goods given away as Charity: if some goods from the business are given away as charity

to a particular person or institution, it should be debited to charity account and credited to

purchases account.

6. Compound journal entry: if there are two or more transactions of a similar nature

occurring on the same day and either Dr. or Cr. Account is common, such transactions can be

conveniently recorded in the form of one journal entry instead of making a separate entry for

each transaction. Such entry is known as compound journal entry.

7. Opening entry: the balances of the previous year are brought forward in the beginning of

the year by means of an entry in a going concern. Such entry is made on the basis of

accounting equation i.e., by debiting all assets and crediting liabilities and capital account.

8. Cash Discount: This discount is allowed by a creditor to a debtor when the latter pays the

amount of goods purchased by him either immediately or within a specified period. It is an

incentive given to a debtor for making an early payment. Thus if the seller allows 2%

discount for payment within month. On a bill of Rs. 20,000, the customer would pay Rs.

19,600 if the payment is made within a month otherwise he would have to pay Rs. 20.000

i.e., full amount of the bill. This discount is recorded in the books of accounts and a separate

account is opened in the ledger. Being a nominal account discount allowed is debited and

discount received credited. For examples:


i) cash received from Mahesh Rs. 1900 and allowed him discount Rs.100

Cash A/c Dr. 1,900

Discount A/c Dr. 100

To Mahesh’s A/c 2,000

ii) Paid to Suresh Rs. 20,000 less 2% cash discount.

Suresh A/c Dr. 20,000

To Cash A/c 19,600

To discount A/c 400

(Cash paid and discount received)

9. Trade discount: it is a deduction on the gross value or list price of goods allowed by

the manufacturer to the wholesaler or a wholesaler to a retailer in order to enable them to

sell the goods further at list price to the consumer and yet earn a profit. Suppose, a

manufacturer produced an article for Rs. 40 may fix Rs,100 as list price and allows 35%

discount to the wholesaler. The wholesaler will thus get it at Rs.65 and may sell to the

retailer at 20% trade discount. The retailer would thus get it for Rs. 80 and sell to the

consumer at Rs. 100. Thus, the manufacturer earns a profit of Rs.25, the wholesaler Rs.

15 and the retailer Rs.20. it is deducted from the invoice or cash memo itself from gross

value of goods and is not recorded at all in the books of account. The journal entry will be

passed with the net value of goods. For example, bought goods worth Rs.6,000 from Ram

less 20% trade discount.

Purchases A/c Dr. 4,800

To Ram’s A/c 4,800

(For goods purchased from Ram)

Sometimes the purchaser may get the benefit of both discounts. In such a case, firstly

trade discount is calculated on the gross value of goods sold and then cash discount is

calculated on the net value of goods. For example, bought goods worth Rs.6,000 from

Ram less 29% trade discount and paid in cash full less 2% cash discount.


Purchases Account Dr. 4,800

To Cash 4,704

To Discount A/c 96

(For goods purchased for cash and discount received)

If the payment is made in part then cash discount is calculated only on the amount

paid and not on the total value of goods bought or sold. For example – Bought goods

worth Rs.6,000 less 20% trade discount and 2% cash discount and paid half the amount in

cash

Purchases A/c Dr. 4,800

To Supplier’s A/c 2,400

To Cash A/c 2,352

To Discount A/c 48

( For goods purchased and half the amount paid in cash less 2% cash discount)


2.1.2. Difference between Trade Discount and Cash Discount

The following are the main differences between trade discount and cash discount.

Basis of Distinction Trade Discount Cash discount

1. When allowed

2. Purpose

3. Vary with

4. Entry in books

5. Deduction

6. When offered

7. Form

It is allowed on a certain

quantity being purchased

or as trade practice.

It is given to promote

sales.

It may vary with the

quantity of goods

purchased.

It is not recorded in the

books of account.

It is deducted from the

Invoice.

It is offered at the time of

sale or purchase.

It is usually given in

percentage. it is given on

the list price or catalogue

price or retail price.

It is allowed when

payment is made before a

certain date.

It is allowed to encourage

early cash payment.

It may vary with the

period within which the

payment is to be made.

A separate account in the

ledger is maintained for

such discount.

It is not deducted from the

invoice.

It is offered at the time of

getting quick payment.

It may be given in

percentage or in absolute

figure.


2.2SUBSIDIARY BOOKS:

Subsidiary Books are those books of original entry in which transactions of similar

nature are recorded at one place and in chronological order.

In a big concern, recording of all transactions in one Journal and posting them into

various ledger accounts will be very difficult and involve a lot of clerical work.

This is avoided by sub-dividing the journal into various subsidiary journals or books.

The subdivisions of journal into various subsidiary journals for recording transactions

of similar nature are called as ‘Subsidiary Books.’

2.2.1TYPES OF SUBSIDIARY BOOKS

1. Purchases Day Book – for recording credit purchase of goods only. Cash purchase or

assets purchased on credit are not entered in this book.

2. Sales Day Book – for recording credit sales of goods only. Assets sold or cash sales are

not recorded in this book.

3. Purchases Returns Book – for recording the goods returned to the suppliers when

purchased on credit.

4. Sales Returns Books – for recording goods returned by the customers when sold on credit.

5. Bills Receivable Book – for recording the bills received [Bills Receivables] from

customers for credit sales.

6. Bills Payables Book – for recording the acceptances [Bills Payables] given to the suppliers

for credit purchases.

7. Cash Book – for all receipts and payments of cash.

8. Journal Proper – for recording any transaction which could not be recorded in the above-

mentioned subsidiary books. For example, assets purchased or sold on credit and opening

entry etc., are entered in this book.


2.3LEDGER:

As we know, journal records all business transactions separately and date wise.

The transactions pertaining to a particular person, asset, expense or income are

recorded at different places in the journal as they occur on different dates.

Hence, journal fails to bring the similar transactions together at one place.

Thus, to have a consolidated view of the similar transactions different accounts are

prepared in the ledger.

A ledger account may be defined as a summary statement of all the transactions

relating to a person, asset, expense or income which have taken place during a given

period of time and shows their net effect.

Thus, a journal is maintained only to facilitate the passing of entries in the ledger, so

every entry recorded in the journal must be posted into the ledger.


Ledger is a register having a number of pages which are numbered consecutively.

One account is usually assigned one page in the ledger.

However, if the transactions, pertaining to a particular account are more, it may be

assigned more than one page in the ledger.

An index of various accounts opened in the ledger is given at the beginning of the

ledger for the purpose of easy reference.

It is the principal book of accounts because it helps us in achieving the objectives of

accounting. It gives answers to the following pertinent questions:

1. what are the total sales to an individual customer?

2. what are the total purchases from an individual supplier?

3. how much amount is owed by others?

4. how much amount is owed to others?

5. what is the amount of profit or loss made during a particular period?

2.3.1 Advantages or merits:

It provides complete information about all accounts in one book.

It is easy to ascertain how much money is due to suppliers (from creditors ledgers)and

how much money is one from customers (from debtors ledgers).

It enables to ascertain, what are the main items of revenue or incomes (nominal

account).

It enables to ascertain what are the main items expenses (nominal account)

It enables to know the kind of assets the company holds and their respective values

(real account)

It facilitates preparation of trial balance and thereafter preparation of financial

statements i.e., P&L A/c and balance sheet.

2.3.2 Differences between Journal and Ledger:

S.NO Basis of difference Journal Leger

1.

Nature of Book

It is a book of original entry It is a book of final entry.

2.

Object It is prepare to record all the

transactions in chronological

order (date wise)

It is prepare to know the

effect of various

transactions affecting a

particular account.

3.

Basis of Preparation

It is prepared on the basis of

transactions.

It is prepared on the basis

of journal.


4. Stage of recording

Recording in the journal is the

first stage.

Recording in the ledger is

the second stage.

5.

Balancing

Journal is not balanced

All ledger A/c are balanced.

6.

Narration

Narration is written for each

entry.

No narration is given

7.

Format

In journal there are 5 columns

viz, date, particulars, L.F. Dr

and Cr.

In ledger there are 4

columns on debit and

credit side viz. date,

particulars, journal folio

and amount.

8.

Name of the process

The process of recording in

journal is called journalizing.

The process of recording in

ledger is called ledger

posting.

9. Basis of preparation

of Final A/c

Journal directly doesn’t serve as

basis for preparation of final

account.

Ledger serves the basis for

the preparation of final

accounts.

2.4TRIAL BALANCE:

The agreement of the trial balance reveals that both the aspects of each transaction

have been recorded and that the books are arithmetically accurate.

If the trial balance does not agree, it shows that there are some errors which must be

detected and rectified if the correct final accounts are to be prepared.

Thus, trial balance forms a connecting link between the ledger accounts and the final

accounts.

2.4.1 Preparation of trial balance:

1. Total method: in this method, the debit and credit totals of each account are shown in

the two amount columns against it.

2. Balance method: in this method, the difference of each account is extracted. If debit

side of an account is bigger in amount than the credit side, the differences is put in the

debit column of the trial balance and if the credit side is bigger, the difference is written

in the credit columns of the trial balance.


Trial balance can be prepared on a loose sheet having four columns. A specimen is

given as follows:

Trial balance of - - - -As on - - - -

Serial No. Name of the account Dr.

Balance

(or Total )

Rs.

Cr.

Balance

(or Total)

Rs.

Of the two methods of preparation, the second is usually used in practice because it

facilitates the preparation of the final accounts

A trial balance can be prepared by the following two methods:

1. Total method: in this method, the debit and credit totals of each account are shown in the

two amount columns (one for the debit total and the other for the credit total) against it.

2. Balance method: in this method, the difference of each account is extracted. If debit side of

an account is bigger in amount than the credit side, the difference is put in the debit column

of the trial balance and if the credit side is bigger, the difference is written in the credit

column of the trial balance.

Of the two methods of preparation, the second is usually used in practice because it

facilitates the preparation of the final accounts.


2.4.2 Specimen of trial balance

Particulars Debit (Assets & Expenditure)

Rs.

Credit (Liabilities &Incomes)

Rs.

Capital

Purchases

Purchase returns

Sales

Sales returns

Carriage

Wages

All expenses and losses

Direct and indirect

expenses

All incomes and gains

All assets

Current assets, fixed

assets, intangible assets

and fictious assets.

All liabilities

Current liabilities, long-

term liabilities etc.

Discount allowed

Discount received

Drawings

Taxation paid

Dividend paid

Bad debts and reserves

Suspense A/c

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX

XXX XXX


3 .FINAL ACCOUNTS

Two main objectives of maintaining accounts are to find out the profit or loss made

by the business at the end of regular periodic intervals and to ascertain the financial

position of the business on a given date.

Final accounts are prepared to achieve the objectives of accountancy.

In order to know the profit or loss earned by a firm, Income Statement or Trading and

Profit and Loss account is prepared.

Balance Sheet or Position Statement will portray the financial condition of the firm on

a particular date. These two statements, i.e., Trading and Profit & Loss Account and

Balance Sheet are prepare to give the final results of the business, that is why both

these are collectively called as final accounts.

Thus, final accounts include the preparation of :

I. Trading and Profit and Loss Account; and

II. Balance Sheet.

Final accounts are the means of conveying to management, owners and interested

outsiders a concise picture of profitability and financial position of the business. The

preparation of the final account sis not the first step in the accounting process but they are the

end products of the accounting process which give a concise accounting information of the

accounting period after the accounting period is over. These accounts summarize all the


accounting information recorded in the subsidiary books and the ledger running into hundreds

or thousands of pages.

3.1 TRADING ACCOUNT

Particulars Amount

Rs. Particulars

Amount

Rs.

To Opening Stock

To Purchases

Less: Purchase

Returns

To Direct Expenses

To Carriage Inward

To Wages

To Wage and Salaries

To Fuel and Power

To Manufacturing or

Production

Expenses.

To Coal, Water and

Gas

To Motive Power

To Factory Lighting

To Octroi

To Import Duty

To Custom Duty

To Excise Duty

To Consumable Stores

To Foreman/Works

Manager’s

Salary

To Factory Rent,

Rated and

Taxes

To Royalty on

Manufactured

Goods

To Gross Profit C/d

By Sales

Less: Sales

Returns

By Closing Balance

By Gross Loss C/d

XXXX XXXX


3.2PROFIT AND LOSS ACCOUNT:-

This account is prepared to calculate the net profit of the business.

There are certain items of incomes and expenses of the business which must be taken

into consideration for calculating net profit of the business.

These are of indirect nature, i.e., concerning the whole business and relating to

various activities which are done by the business for the purpose of making the goods

available to the consumers.

Indirect expenses may be selling and distribution expenses, management expenses,

financial expenses, extraordinary losses and expenses to maintain the assets into

working order.

This account is prepared from nominal accounts and its balance is transferred to

capital account as the whole profit or loss will be that of the owner and it will increase

of decrease his capital.

The specimen proforma of this account is given as under.

PROFIT AND LOSS A/C,For the year ended 31st March,2000

To Gross Loss b/d

To Selling and Distribution

Expenses:

Advertisement

Travelers’ Salaries,

Expenses & Commission

Bad Debts

Carriage Outward

Bank charges

Agent’s Commission

Upkeep of Motor Lorries

To Management Expenses:

Rent, Rates and Taxes

Heating and Lighting

office Salaries

Printing & Stationery

Postage & Telegrams

Telephone Charges

Legal Charges

Audit Fees

Insurance

General Expenses

To Depreciation and

Maintenance:

Rs. By Gross Profit b/c

By Interest Received

By Discount Received

By Commission Received

By Rent From Tenants Received

By Income from Investments

By Apprenticeship Premium

By Interest on Debentures

By Income from any other Source

By Miscellaneous Revenue Receipts

By Net Loss transferred to Capital A/c*


Depreciation

Repairs & Maintenance

To Financial Expenses:

Discount Allowed

Interest on Capital

Interest on Loans

Discount on Bills Discounted

To Extraordinary Expenses:

Loss by fire (not covered by

Insurance)

Cash Defalcations

To Net Profit transferred to

Capital A/c*

* Balancing figure will be either net profit or net loss.

3.3BALANCE SHEET

A balance sheet is a statement prepared with a view to measure the financial position of

a business on a certain fixed date.

The financial position of a concern is indicated by its assets on a given date and its

liabilities and that date.

Excess of assets over liabilities represent the capital and is indicative of the financial

soundness of a company; a balance sheet is also described as a ‘statement showing the

sources and application of capital’.

It is a statement and not an account and prepared from real and personal accounts.

The left hand side of the balance sheet may be viewed as a description of the sources

from which the business has obtained the capital with which it currently operates and

the right hand side as a description of the form in which that capital is invested on a

specified date.

On the left hand side of the balance sheet, the several liability items described how

much capital was obtained from trade creditors, from banks, from bill holders and other

outside parties. The owner’s equity section shows the capital supplied by the owner.


Grouping and Marshalling of Assets and Liabilities:

Liabilities Amount

Rs. Assets

Amount

Rs.

Current Liabilities:

Bills Payable

Sundry Creditors

Bank Overdraft

Long Term Liabilities:

Loan from Bank

Loan from Wife

Fixed Liabilities:

Capital

Liquid Assets:

Cash in Hand

Cash at Bank

Floating Assets: Sundry Debtors

Investments

Bills Receivable

Stock in Trade

Prepaid Expenses

Fixed Assets: Machinery

Building

Furniture & Fixtures

Motor Car

Intangible Assets:

Goodwill

Patents

Copyright

Licenses

Fictitious Assets:

Advertisement

Misc. Expenses

(to the extent not written off)

Profit & Loss A/c

3.4 Treatment of items appearing in the trial balance:

Items Profit & loss account Balance sheet

1. closing stock ___________________ Shown in the asset side of

balance sheet.

2. outstanding expenses or

accured expenses

Shown in the liability side

of balance sheet.

3. prepaid expenses

Shown in the asset side of

the balance sheet

4. Accrued income

Shown in the asset side of

balance sheet.

5. unearned income

Shown in the liability side

of the balance sheet.

6. Depreciation Shown in the Dr side of

Profit & Loss account

7. Interest on capital Shown in the Dr side of

Profit & Loss account

8.drawings

Less from capital on the

balance sheet liabilities side


4. FINAL ACCOUNTS WITH ADJUSTMENTS

While preparing trading and profit and loss account one point that must be kept in

mind is that expenses and incomes for the full trading period are to be taken into

consideration.

This means that if an expense has been incurred but not paid during that period, a

liability for the unpaid amount should be created before the accounts can be said to

show the profit or loss.

All expenses and incomes should properly be adjusted through entries.

These entries which are passed at the end of the accounting period to make a record of

the transactions omitted to be entered in the books are called adjusting entries.

Hence before preparing final accounts adjusting entries should be made to ensure that

final accounts exhibit a true and fair view.

Some important adjustments which are to be made at the end of the accounting year

are discussed in the following pages one by one.

Every adjustments item will come two times or three times. In the final accounts all

trial balance items will come only one time in the final accounts.

Treatment of adjustment items in the final accounts:

Adjustments Trading

account

Profit & loss

account

Balance sheet

1. closing stock Shown in

the cr side

of trading

account.

Shown in the asset side

2.outstanding

expenses

Shown in the Dr side

of trading or profit &

loss account by way

of addition to the

concern expenses.

Liability side of balance sheet

3.unexpired or

prepaid expenses

Shown in the Dr

profit and loss

account by the way

of deduction from

concern expenses.

Shown on the asset side of the

balance sheet.

4.Accrued income Showing in the Cr

profit & loss account

by the way of

addition concerning.

Shown on the addition to the

asset side balance sheet.

5. Income received

in advance

It is shown on the

profit and loss

account by the way

of deduction from

Shown on the liabilities side of

balance sheet.


concern income.

6. Depreciation Shown on

the Dr side

of Profit

and loss

account.

Shown on the asset side by way

of deduction from the concern

asset.

7. Interest on

capital

Shown in the Dr side

of profit & loss

account


the balance sheet by way of

adding to the capital.

8.Interest on

drawings

Shown on the “cr”

side of profit & loss

account



addition to the drawings which

are ultimately redacted from the

capital

9.Provision of

doubtful debts

Shown on the “Dr”

side of P/L account

or by way of addition

to bad debts (old

provision for

doubtful debts at the

beginning of the year

will be deducted)

Shown on the assets side by way

of deduction from the sundry

debtors ( after deduction of

further bad debts) if any

10.Provision for

discount on

debtors


side of P/L account

Shown by way of deduction from

sundry debtors (after deduction

of further bad debts & provision

for doubtful debts) on the asset

side of the balance sheet

11.additional bad

debts


side by way of

addition to the bad

debts

Shown the assets side by way of

deduction from the amount of

sundry debtors.

12.Reserve for

discount on

creditors

Shown on the Cr side

of P/L account



deduction from sundry creditors.

13.Deferred

Revenue

Expenditure


side of P/L account

(some proportionate

amount on deferred

revenue expenses)

Shown on asset side by way of

deduction from capitalized

expenditure.

15. bad debts Shown on the debit

side of Profit & loss

account.

Shown on the assets side of the

B/S by way of deduction from

sundry debtors.

16.(Interest On

Loan)hidden

adjustments

Shown on the Dr

side of the P/L

account by way of

addition to the

interest on loan.



addition to the loan account.


5. ACCOUNTING PRINCIPLES

Accounting principles

a) ACCOUNTING CONCEPTS b) ACCOUNTING CONVENTIONS

a) ACCOUNTING CONCEPTS:

1. Money measurement Concept: This means that the accounting record is made only

of those transactions, which can be measured and expressed in terms of money.

2. Business Entity Concept: Accounting assumes that business is a separate entity

distinct forms its owner under this concept. Business is treated like a legal person

owing is assets, liabilities without such restrictions the affairs of the business will be

mixed with the private affairs and entire picture of the business.


3. Going Concern Concept: It means that in accounting a concern that will continue to

operate for an indefinite long period of time.

4. Cost Concept: This concept states that assets are recorded at the actual cost to the

business and not the market values or some other imaginary values.

5. Dual Aspects Concept: Every business transaction involves dual or double aspect of

equal value is called dual aspect concept. The accounting equation is

Assets –Liabilities + Capital

6. Accounting Period Concept: It means that measuring the financial results of a

business periodically. The business working life is split into convenient short period

of time is called accounting period. Financial position of the business is ascertained at

the end of the accounting period by preparing financial statements.

7. Objective Evidence Concept: It means that all accounting entities should be

evidenced and supported by source documents such as invoice, vouchers etc.,

8. Revenue Realization Concept: It means that revenue is earned by sales of goods or

from provisions of services to customers and revenue is to be recognized or

considered to be realized only when goods or services transferred to a customer and

the customer becomes legally liable to pay for it.

9. Accrual Concept: This concept means that when a transaction has been entered in to

its consequences will certainly follow so all transaction must be brought into record

whether they are settled in cash or not.

10. Matching Concept: Expenses incurred in the accounting period should be matched

with revenue realized in that period. Thus if revenue is realized on goods sold in a

period all expensed attributable to that sales should be recorded in that period.

b) ACCOUNTING CONVENTIONS:

1. Full disclosure concept: This concept deals with the convention that all information

which is of material importance should be disclosed in the accounting statements. The

companies act, 1956 makes it compulsory to provide all the information in the

prescribed form. The accounting reports should disclose full and fair information to

the proprietors, creditors, investors and others. This convention is specially significant

in case of big business like Joint Stock Company where there is divorce between the

owners and the managers.


2. Materiality concept: Under this concept the trader records important facts about the

commercial activities in the form of financial statements. If any unimportant

information is to be given for the sake of clarity, it will be given as footnotes.

3. Consistency concepts: The methods or principles followed in the preparation of

various accounts should be followed in the years to come. It means that there should

be consistency in the methods or principles followed. Or else, the results of one year

cannot be conveniently compared with that of another. For example, a company may

adopt straight line method, written down value method, or any other method of

providing depreciation on fixed assets. But it is expected that the company follows a

particular method of depreciation consistently.

4. Conservatism concept: This convention warns the trader not to take unrealized

income into account. That is why the practice of valuing stock at cost or market price,

whichever is lower is in vogue. This is the policy of “playing safe”. It takes into

consideration all prospective losses to leaves all prospective profits. The convention

of conservatism should be applied cautiously so that the results reported are not

distorted. Some degree of conservatism is inevitable where objective data is not

available.

UNIT-2- IMPORTANT QUESTION

Explain Accounting process/cycle

How to prepare ledger, trail balance & final accounts explain with steps?

How to post adjustment items in final accounts: Outstanding expenses, prepaid

expenses, depreciation, interest on capital, drawings, discounts &other adjustments.

Problems: JOURNAL, LEDGER, TRAIL BALANCE & FINAL ACCOUNTS)

Trading & profit & loss A/C, Balance sheet)






















Textbooks:




References:




Pearson Education






UNIT-3 Valuation of assets | BALAJI INSTITUTE OF IT AND MANAGEMENT 2

UNIT-3

VALUATION OF ASSETS

1. INTRODUCTION TO DEPRECIATION

1.1 Valuation of fixed assets:The broad meaning of Valuation of fixed assets is Valuation of

Land, Building, Plant and Machinery, etc.

Valuation of Fixed Assets is undertaken as per the client’s requirement. Sometimes Financial

Institutions, Banks & Customs authorities also need valuation reports for certain specific

assets.

1.2 Definition of 'Asset Valuation'

A method of assessing the worth of a company, real property, security, antique or other item

of worth. Asset valuation is commonly performed prior to the sale of an asset or prior to

purchasing insurance for an asset.

1.3 What is the Difference Between Tangible and Intangible Assets?

In the world of accounting, understanding the difference between tangible and

intangible assets is very important to keep track of a company's property. A tangible

asset is anything that has a physical existence, meaning that it can actually be seen or

felt by a person. An intangible asset is anything that a company owns that does not

have a physical existence, meaning things like information and company logos. Both

types of assets are very important parts of a company, and accountants need to be able

to recognize both types of these assets.

One type of tangible assets are known as long-term assets. These are physical things

that a company owns and expects to have for a long period of time. The most

common examples of these types of assets include land, equipment, and buildings.

Over time, all of these assets, except for land, have to be depreciated by an accountant

working for the company. This means that they are not worth as much as time goes on

as they were originally purchased for.

Buildings and equipment used by the company are depreciated as time passes.

Additionally, companies incur other costs that have to be factored in to their balance

sheet. For example, some building costs include the original price of the purchase of

the building, any taxes that the company had to pay when purchasing the building,

any kind of fees for attorneys and realtors, and any potential costs of having to fix up

or maintain the building. Some equipment costs include the original price that the

equipment was bought for, any taxes that had to be paid to purchase the equipment,

the costs incurred for installing the equipment, and if the item was delivered, the cost

for delivery.


Land is different from other tangible assets in that it does not depreciate, but instead is

held to its historical cost. This means that it remains at the same price on the balance

sheet whether the appraisal value goes up or down. It also sees some of the same

additional costs as buildings and equipment do. For example, in addition to the price

that the land was purchased for, companies have to factor in any potential taxes and

any potential fees for people involved with the purchase.

1.4Concept of Depreciation:

a)Depreciable asset. These are assets which

i) are expected to be used during more than one accounting period: and

ii) have a limited life ; and

iii) are held by an enterprise for use in the production or supply of goods and services

for rental to others, or for administrative purposes and not for the purpose of sale

in the ordinary course of business.

b) Useful life. This is either (i) the period over which a depreciable asset is expected to be

used by the enterprise; or (ii) the number of production of similar units expected to be

obtained from the use of the asset by the enterprise.

The useful life of a depreciable asset is shorter than its physical life and is:

(i) pre-determined by legal or contractual limits such as the expiry dates of related

lease ;

(ii) directly governed by extraction or consumption ;

(iii) dependent on the extent of use and physical deterioration on account of wear and

tear which again depends on operational factors, such as, the number of shifts for

which the asset is to be used, repairs and maintenance policy of the enterprise etc.,

and

(iv) Reduced by obsolescence arising from such factors as technological changes,

improvement in production methods, change in market demand for the product or

service, output of the asset or legal or other restrictions.

(c)Depreciable Amount. The amount of depreciable asset is its historical cost, or other

amount substituted for historical cost in financial statements, less the estimated residual

value.

(d)Residual Value. Determination of residual value of an asset is normally a difficult

matter. If such value is considered as insignificant, it is normally regarded as nil. On the

contrary, if the residual value is likely to be significant, it is estimated at the time of

acquisition/installation, or at the time of subsequent revaluation of the asset.


1.5 Cause of depreciation

The following are the main causes of depreciation:

(i) Physical Deterioration. It is caused mainly from wear and tear when the

asset is in use and from erosion, rust, rot and decay from being exposed to

wind, rain sun and other elements of nature.

(ii) Economic Factors. These may be said to be those that cause the asset to

be put out of use even though it is in good physical condition. These arise

due to obsolescence and inadequacy. Obsolescence means the process of

becoming obsolete or out of date. An old machinery though in good

physical condition may be rendered obsolete by the introduction of a new

model which produces more than the old machinery.

(iii) Time factors. There are certain assets with a fixed period of legal life such

as lease, patents, and copyrights. For instance, a lease can be entered into

for any period while a patent’s life is for some years but on certain grounds

this can be extended. Provision for the consumption of these assets is

called amortization rather depreciation.

(iv) Depletion. Some assets are of a wasting character perhaps due to the

extraction of raw materials from them. These materials are then either used

by the firm to make something else or are sold in their raw state to other

firms. Natural resources such as mines, quarries and oil wells come under

this heading. To provide for the consumption of an asset of a wasting

character is called provision for depletion.

(v) Accident. An asset may reduce in value because of meeting of an accident.

1.6 Difference between Depreciation, Depletion, Amortization and Dilapidations

Depreciation applies to fixed assets, depletion to wasting assets, amortizations to

intangible assets and dilapidation to damage due to a building or other property during

tenancy. AICPA has given the difference between these terms in the following words:

“Depreciation can be distinguished from other terms, with specialized meaning used

by accountants to describe assets cost allocation procedures. Depreciation is

concerned with charging the cost of man-made fixed assets to operations (and not

with determination of asset value for the balance sheet). Depletion refers to cost

allocations for natural resources such as oil and mineral deposits.

Amortization relates t cost allocation for intangible assets such as patent and

leaseholds. The use of the term depreciation should also be avoided in connection

with the valuation procedures for securities and investments.”


2. METHODS OF DEPRECIATION:

Different methods of calculating provision for depreciation are mainly accounting

customs which may be used by different concerns taking into consideration their individual

peculiarities. The following are the main methods of providing depreciation:

2.1 Fixed Installment (or Fixed Percentage on Original Cost or Straight Line) Method

Under method a fixed percentage of the original value of the asset is written off every

year so as to reduce the asset account to nil or to its scrap value at the end of the estimated

life of the asset. To ascertain the annual charge under this method all that is necessary is

to divide the original value of the asset (minus its residual value, if any) by the number of

years of its estimated life i.e.,

Depreciation = Cost price of asset – Scrap Value

Estimated life of asset

If, for example, a machine costing Rs. 11, 000/- is estimated to have a life of 10 years and the

scrap value is estimated Rs. 1, 000/- at the end of its life, the amount of depreciation would

be

Rs. 11,000-1,000 = Rs. 1,000

10

The amount of depreciation charged during each period of the asset’s life is constant.

If the charge of depreciation is plotted annually on a graph paper and the points joined

together, then the graph will reveal a straight line that is why it is also called as straight line

method.

This method is suggested in case of assets where in the service value declines as a

function of time and that too at a uniform rate. The repairs, maintenance and revenue also

remain more or less constant.

It should be noted carefully that if depreciation is given as some percentage per

annum and if the asset is purchased during the accounting year, say on July 1st then

depreciation for six months is to be charged, if the accounting year closes on 31st December.

2.1.1 Merits of Fixed Installment Method

i. This method is simple to understand and easy to apply.

ii. It can write down an asset to zero at the end of its working life, if so desired.

iii. This method is very suitable for those assets which have a fixed life e.g.,

furniture, fixtures, short leases, patents and copyright and other assets of a

small intrinsic value, repair charges are less and the possibility of

obsolescence also less.


2.1.2 Demerits of Fixed Installment Method

i. The charge for depreciation remains constant year after year. The expenses of

repairs and maintenance are increasing as the asset grows older. The profit and

loss account thus in the later years bears more than its share of valuation.

ii. It becomes difficult to calculate the depreciation on additions made during

year.

iii. Under this method the depreciation charge remains the same from year to year

irrespective of the use of the asset. Thus it does not take into consideration the

effective utilization of the asset.

iv. It is not take into consideration the interest on capital invested in fixed assets.

v. It does not provide funds replacement of assets.

vi. This method tends to report an increasing rate of return on investment in the

asset amount due to the fact that the net balance of the asset amount is taken.

In spite of these drawbacks, this method is mostly used by firms in U.S.A

Canada, U.K., and some firms in India.


2.2. Diminishing Balance (or Reducing Installment or Written Down Value) Method

Under this method, depreciation is calculated at a certain percentage each year on the

balance of the asset which is brought forward from the previous year;

The amount of depreciation charged in each period is not fixed but it goes on

decreasing gradually as the beginning balance of the asset in each year will reduce.

The charges in initial periods are higher than those in the later periods.

Overall charges, i.e., amount of depreciation, repairs and maintenance taken together

remains equal throughout the life of the asset.

This method is justified in the cases where 1. there is much uncertainty of revenue in

later years and 2.

there is also increase in repairs and maintenance costs consequently decreasing

efficiency and revenues in every succeeding period. It is usually adopted for plant and

machinery.

2.2.1 Merits of Diminishing Balance Method

i. It tends to give a fairly even charge of depreciation against revenue each year.

Depreciation is generally heavy during the first few years and is counter –

balanced by the repairs being light and in the later years when repairs are

heavy this is counter – balanced by the decreasing charge for depreciation.

This concept is based on the logic that as an asset grows order, the amount of

depreciation goes on decreasing.

ii. Fresh calculations of depreciation are not necessary as and when additions are

made.

iii. This method is recognized by the income tax authorities in India.

iv. It does not provide for replacement of asset on the expiry of its useful life.

v. This method is suitable for plant and machinery, building etc. Where the

amount of repairs and renewals increase as the asset grows older and the

possibilities of assets are more.

2.2.2 Demerits of Diminishing Balance Method

i. The original cost of the asset is altogether lost sight of in subsequent years and

the asset can never be reduced to zero.

ii. This method does not take into consideration the asset as an investment and

interest is not taken into consideration.

iii. As compared to the first method, it is difficult to determine the suitable rate of

depreciation.


2.2.3 DISTINCTION BETWEEN STRAIGHT LINE METHODSAND DIMINISHING

BALANCE METHOD

Points of

Distinction Straight Line Method

Diminishing Balance

Method

1. Change in

Depreciation

Amount

2. Balance in

Assets A/c

3. Overall

Changes

4. Profits

Throughout the life of the asset, the

amount for depreciation remains to be

equal.

Assets A/c at the expiry of the expected

life becomes nil.

The overall charge i.e., Depreciation

and repairs taken together go on

increasing from year to year. In other

words the amount depreciation and

repairs is relatively less during the

earlier years of the life of the asset than

later years become repairs go on

increasing with use of asset.

Profits under this method are more

during the earlier years of the life of the

asset.

Amount of depreciation is more during

earlier years of the life of asset than

later years and therefore amount is

never equal.

The amount never becomes nil.

Overall charge remains more or less

same for every year throughout the life

of the asset. Since depreciation goes on

decreasing and amount of repairs goes

on increasing.

Profits are less during earlier years than

the later years.


2.3 ANNUITY METHOD

1. The fixed Installment Method and the Reducing Balance method of charging

depreciation ignore the interest factor.

2. The Annuity Method takes care of this factor. Under this method, the depreciation is

charged on the basis that besides losing the original cost of asset, the business also

losses interest on the amount used for buying the asset.

3. The terms “Interest” here means the interest which the business could have earned

otherwise if the money used in purchasing the asset would have been invested in some

other form of investment.

4. Thus, according to this method, such an amount is charged by the way of depreciation

which taken into A/c not only the cost of the asset but also interest there on at an

accepted rate.

5. The amount of interest is calculated on the book value of the asset, in the beginning of

each year.

6. The amount of depreciation is uniform and is determined on the basis of annuity table.

Follows: Rs. 5,000 x 2.48685 = Rs 12,434 or (say) Rs 12,500.

UNIT-3 IMPORTANT QUESTIONS Explain Methods of Depreciation with merits &de-merits?

Depreciation problems: Straight Line, Diminishing Balance &annuity Method.

(17E00104) FINANCIAL ACCOUNTING FOR MANAGERS * …

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